European shares sold off broadly on Monday and investors braced for further losses as concerns that Spain may need a full sovereign bailout heightened alarm about the euro zone.
Euro zone banks fell 5.3 percent to an all time-low after a second Spanish region, Murcia, looked set to follow Valencia in tapping government money to keep afloat. Local media reported half a dozen regions were ready to follow suit, sending Madrid's borrowing costs to all-time highs.
Spain's Ibex index was down 4 percent while Milan's FTSE MIB shed 4.4 percent to its lowest euro-era level as investors fretted that Italy - one of the world's biggest sovereign debtors - would be next in line.
Concerns were exacerbated by the fact that the European Stability Mechanism, the euro zone's bailout fund, must await approval by the German Constitutional Court in a ruling scheduled for Sept. 12.
Until Sept. 12, there can only be one direction for equity markets, that is down, because you don't know whether the ESM will ever go live, said Tobias S. Blattner, director of European research at Daiwa Capital Markets.
In that sense I think the whole survival of the euro area will critically depend on that decision.
He saw 5-10 percent downside on the euro zone Euro STOXX 50 index in the run up to the German court's decision. The index had shed 2.1 percent to 2,189.68 points at around 1030 GMT on Monday.
Blattner said another intervention by the European Central Bank through a round of cheap loans to banks could calm markets this summer, but saw any monetary stimulus from the U.S. Federal Reserve as unlikely until the fourth quarter.
Charts on the Euro STOXX 50 September futures also suggested more downside in the very short term after the contract opened well below Friday's low and shed a further 2.3 percent to 2,186 points.
Philippe Delabarre, a technical analyst at Trading Central in Paris, said he expected the future to head towards support levels at 2,167 and 2,154, while he set a stop-loss for his bearish trade at 2,240.
The derivative market also showed investors were positioning for a bumpy ride with the Euro STOXX 50 implied volatility index , which uses options to gauge expectations of future share price swings, rising 23 percent on Monday.
The index, known as VSTOXX and regarded as a measure of investor 'anxiety', had hit a five-month low on Thursday before climbing 16 percent on the following day, when Valencia became the first Spanish region to apply for a bailout.
The move is even small in relation to what is happening (in Spain), a London-based derivative trader said.
You are finally starting to see buyers of volatility because investors are realising these levels are still low compared to 2008.
The VSTOXX hit a peak of 87.88 at the height of the U.S. financial crisis in 2008, and touched a trough of around 17 in March this year after ECB flooded the euro zone banking sector with cheap funding to ease pressure in the sovereign and interbank markets. It was trading around 29 on Monday.
The FTSEurofirst 300 index was down 1.9 percent at 1,034.16 points, having traded 40 percent of its full-day volume average by around 1030 GMT.
Philips Electronics, up 7 percent, was the top riser on the index after Europe's largest consumer electronics producer reported higher revenues and profits in the second quarter, boosted by improved sales of hospital equipment.
The European earnings season has got off to a bullish start, with 58 percent of companies that have reported so far - around one sixth of those due to do so - meeting or beating forecasts, according to Thomson Reuters StarMine data.
The fresh downleg for cash equities may have caught some investors off guard after a 3.4 percent rise in the five sessions to last Thursday, when a string of estimate-beating results and speculation about further monetary stimulus lifted sentiment.
Investment bank Nomura said in a note its fund flow sentiment indicator made a decisive upward move last week, albeit from a bearish level to one that was neutral.
However the bank cautioned that the upward move has been driven by a slowing in the pace of selling as opposed to any significant net new investment.